EFTA01158281.pdf

0±,ProSep Together, creating pure oil, gas and water. Management Discussion and Analysis November 10, 2010 For the third quarter and nine-month period ended September 30.2010 This Management Discussion and Analysis ("MD&A") should be read in conjunction with the Unaudited Interim Consolidated Financial Statements of ProSep Inc. ("ProSep" or the "Company") for the three- and nine-month periods ended September 30, 2010 and 2009, as well as the Company's Annual Audited Consolidated Financial Statements and MD&A for the year ended December 31, 2009. Regulatory Filings The Company's continuous disclosure material, including interim filings, annual MD&A and Audited Consolidated Financial Statements, Annual Information Form and Notice of Annual Shareholder Meeting and Proxy Circular, are available at www.sedar.com and on the Company's website at www.prosepinc.com. Caution Regarding Forward-Looking Statements This MD&A may contain forward-looking statements, including statements regarding ProSep's business and anticipated financial performance. Such statements are based on, among other things, management's current assumptions, expectations, estimates, objectives, plans and intentions regarding projected revenues and expenses, the economic and industry conditions in which the Company operates or which could affect its activities, and the Company's ability to attract new clients and consumers, as well as its operating costs, raw materials and energy supply. Forward-looking statements can generally be identified by the use of the conditional tense, the words "may", "should", "would", "believe", "plan", "expect", "intend", 'anticipate', "estimate", "foresee", "objective" or 'continue" or the negative of these terms or variations of them or words and expressions of similar nature. Actual results could differ materially from the conclusion, forecast or projection stated in such forward-looking information. These statements are subject to a number of risks and uncertainties that may cause actual results to differ materially from those contemplated by the forward-looking statements. Some of the factors that could cause such differences include, but are not limited to, the Company's ability to develop, manufacture, and successfully commercialize value-added equipment and services, the availability of funds and resources to continue its operations and pursue its projects, legislative or regulatory developments, competition, technological change, changes in government and economic policy, inflation and general economic conditions in geographic areas where ProSep operates. These and other factors should be considered carefully, and undue reliance should not be placed on the forward-looking statements. Use of Estimates In the preparation of financial statements in accordance with Canadian generally accepted accounting principles ("GAAP"), management must make estimates and assumptions that affect the figures reported as assets and liabilities and contingent assets and liabilities at the date of the financial statements, as well as figures reported as revenues and expenses for the period. Actual results could differ from these estimates. Allamounts are in Canadian Dollars unless otherwise specified 1 EFTA01158281  Non-GAAP Measures This MD&A contains the terms "Earnings Before Interest, Taxes, Depreciation and Amortization" ("EBITDA") and "Net Invested Working Capital" ("NIWC"), which should not be considered as an alternative to, or more meaningful than, net earnings or cash flow from operating activities as determined in accordance with GAAP, as an indicator of the Company's performance. These terms do not have standardized meanings prescribed by GAAP. ProSep's determination of EBITDA and NIWC may not be comparable to that reported by other companies. Management uses EBITDA, among other measures, to assess the operating performance of the ongoing businesses without the effects of depreciation expenses. The Company excludes depreciation expenses because they largely depend on the accounting methods and assumptions a company uses, as well as on non- operating factors such as the historical cost of capital assets. The following table reconciles EBITDA with net income. Three months ended Nine months ended September 30. September 30, 2010 2009 2010 2009 $ $ $ $ Net loss (1,544,990) (3,440,258) (3,154,374) (12,572.626) Plus Future tax provision (recovery) (201,396) 128.383 (712,156) 100,011 Current tax provision 15,486 (74,047) (351,756) 111.038 Amortization 361,961 410,637 1406,661 1,180,816 (Gain) Loss on sale of assets (800) 25,468 Net Financial charges 528,360 2,742.592 1,695,188 4.773.825 Increase in fair value of long- term investments - (400,000) (375,000) (400,000) Impairment of Goodwill 6.500,000 EBITDA (loss) (841,379) (632.693) (1,765,969) (306.936) NIWC is also used by management to analyze the total amount invested to support outstanding contracts, and is defined as the sum of restricted cash related to letters of guarantee, receivables, inventories and prepaid expenses, less the sum of accounts payable, accrued liabilities and deferred revenue. The following table shows the calculation of this non-GAAP measure. September 30, December 31, 2010 2009 $ $ Restricted cash 2.022,940 Receivables 14,087,022 12.807,205 Inventories 318,418 392,709 Prepaid expenses 707,225 665.162 Total (a) 15,112,665 15.888,016 Less Accounts payable and accrued liabilities 11,921,011 12.836.057 Deferred revenue 224,717 71,796 Total (b) 12,145,728 12.907,853 Net Invested Working Capital (a minus b) 2,966,937 2,980,163 Comparative Figures Where applicable. comparative figures for the financial information related to the three- and nine-month periods ended September 30, 2009. have been reclassified to conform with the September 30, 2010. presentation. 2 EFTA01158282  TABLE OF CONTENTS I. OVERALL PERFORMANCE 4 1.1 Highlights of the Quarter Ended September 30, 2010, and Subsequent Events 4 1.2 Material Events and Important Subsequent Events 4 2. COMPANY OVERVIEW 5 2.1 Business Overview 5 2.2 Corporate Model and Sales Network 6 2.3 Business Environment and Strategy 6 3. PRODUCTS 8 3.1 Market Segments and Product Penetration 8 3.2 Product and Services Overview 9 4. RESULTS OF OPERATIONS 10 4.1 Contracts 10 4.2 Revenues 11 4.3 Cost of Goods Sold and Gross Margin 12 4.4 Goodwill Impairment 15 4.5. Increase in Fair Value of ABCP 15 4.6 Financial Charges 15 4.7 Income Tax 15 4.8 Net Loss 15 4.9 Foreign Currency Translation Adjustment (part of Comprehensive Loss) 15 4.10 Legal Proceedings 16 5. SUMMARY OF QUARTERLY RESULTS 16 6. BALANCE SHEET ITEMS 16 6.1 Assets 16 6.2 Liabilities 17 6.3 Equity 17 7. OFF-BALANCE-SHEET ARRANGEMENTS 17 8. LIQUIDITY AND CAPITAL RESOURCES 18 8.1 Cash Flows 18 8.2 Liquidity and Working Capital 18 8.3 Bank Overdraft Facilities and Obligations under Financial Liabilities 19 8.3.1 Financial Covenants 19 8.3.2 Obligation under Financial Liabilities 19 9. TRANSACTIONS WITH RELATED PARTIES 19 10. DESCRIPTION OF CAPITAL STRUCTURE 19 11. IFRS CHANGEOVER PLAN 20 12. CRITICAL ACCOUNTING ESTIMATES 21 13. INTERNAL CONTROLS 21 14. SELECTED RISKS 23 3 EFTA01158283 1. OVERALL PERFORMANCE 1.1 Highlights of the Quarter Ended September 30, 2010, and Subsequent Events Financial: • Revenues were $8.1 million, a decrease of 11% when compared to $9.2 million for the corresponding period of 2009. Year-to-date, revenues amount to $26.2 million, a 17% reduction from the $31.7 million generated during the first nine months of 2009. • Gross margin of $2 million (24% of revenues) compared to $2.7 million (29%) for the corresponding period of 2009. Year-to-date, gross margin stands at $7.1 million (27%) compared to $9.6 million (30%) for the same period last year. • Net loss of $1.5 million compared with a net loss of $3.4 million for the corresponding period of 2009. Year-to-date, net loss amounts to $3.2 million compared to $12.6 million for the same period last year. Included in the 2009 year-to date net loss were $6.5 million goodwill impairment and debt conversion and settlement costs amounting to $2.1million. Operational and Corporate: • Announced approximately $11million in new contracts during the quarter including its first significant sale for the Canadian Oil Sands market. • Appointed two industry veterans to the Company's executive committee: o Douglas A. Campbell, P.Eng., M.B.A. was appointed Executive Vice President of Sales and Business Development. Mr. Campbell was previously Vice President Marketing and Business Development at NATCO Group where he was intimately involved in the group's international success until its acquisition by Cameron, a leading equipment supplier with over $5 billion in sales. o Parag P. Jhonsa was promoted to Executive Vice President Operations. Mr. Jhonsa previously led the American business unit's engineering and operations teams. • Ranked for a second consecutive year among the Deloitte Technology Fast 501", received a third Green 15 award and ranked fourteenth fastest growing company in the North American Fast 500 edition based on percentage of revenue growth over the last 5 years. • Sales backlog stood at $12.9 million on October 1, 2010, an increase of 32% from the last quarter. Subsequent to quarter-end, ProSep announced an additional US$1.5 million in new contracts (see Section 1.2). 1.2 Material Events and Important Subsequent Events In this section, all material events and commitments for the three-month period are presented, followed by information on important subsequent events, up to the date of this MD&A. On November 4, 2010, ProSep announced the nomination of two new executives. Douglas A. Campbell P. Eng., M.B.A., as Executive Vice President of Sales and Business Development and Parag P. Jhonsa, as Executive Vice President Operations. On October 7, 2010, ProSep announced that it had been awarded a $1.5 million supply contract to provide additional equipment associated with a CO2 gas membrane treatment plant to be delivered to a South American customer. Additional equipment includes the supply of spare gas membranes. On September 27, 2010, the Company announced that it would supply after-market services and spare parts valued at $2 million to clients located in Kuwait and the United States for produced water and gas treatment systems. 4 EFTA01158284 On September 23, 2010, the Company announced that it ranked for a second consecutive year among the Deloitte Technology Fast 50'. a ranking of the 50 fastest growing technology companies in Canada, based on the percentage of revenue growth over the last five years. ProSep ranked seventh with a 10,203 percent revenue growth from 2005 to 2009. The Company also received for the third consecutive year, a Technology Green 151" Award created in 2007 to showcase 15 Canadian companies that are leading the way to create major breakthroughs in the field of green technology. ProSep also ranked 14' fastest growing company according to revenue growth over the last 5 years in the North American Fast 500 edition. On August 24, 2010. the Company received new contracts in the United States, South America and Asia Pacific for a total of US$2.4 million. Under a contract valued at US$1.5 million, ProSep will supply CO? gas separation membrane and hydrocarbon dew point packages for installation at an onshore gas plant in South America. The Company also announced that a second supply agreement had been concluded for the delivery of a nitrogen generator package valued at US$0.5 million to be installed on a Floating Production Storage and Offloading ("FPSO") facility expected to operate in the South China Sea. Under a contract valued at US$0.4 million, ProSep will supply a pitless air drilling de-duster skid for a large international oil services company. On August 9, 2010, the Company was awarded a US$4.1 million contract to supply a gas dehydration system for a natural gas development project located in the South China Sea. On the same day, the Company announced that it had received a contract valued at US$0.5 million to supply a chemical injection package for a leading engineering and construction services provider. On July 8, 2010, ProSep announced that it had been awarded a US$2.0 million contract to provide process engineering and specialized internals for a crude separation solution to be installed at a super major oil and gas producer's steam-assisted gravity drainage ("SAGD") facility located in Alberta's oil sands. 2. COMPANY OVERVIEW 2.1 Business Overview ProSep designs, develops, manufactures, and commercializes process solutions to treat, separate and purify oil, gas, and water for the oil & gas (O&G) upstream industry. ProSep has a wide range of conventional and proprietary process equipment sold in units or in packages to O&G producers and engineering procurement and construction firms ("EPC"), with process warranties. Global Business Model: ProSep is a solutions provider supplying high efficiency process equipment packages with process warranty. ProSep provides: In-house engineering from process to details; and Direct and hands-on involvement with project management that includes fabrication, assembly, commissioning and services. ProSep operates around the world in the most important (MG service hubs, with operations in Houston (USA), Bergen (Norway), Fusa (Norway), Kuala Lumpur (Malaysia), and Manama (Bahrain). Its head office is in Montreal (Canada). ProSep has approximately 100 employees, mainly technical sales people, process engineers, product engineers and project managers as well as workers in its 55,000 square-foot assembly shop located in Houston. 5 EFTA01158285 2.2 Corporate Model and Sales Network ProSep has three diversified business units that promote the Company's solutions across all regional markets. Each business unit has developed its own specific expertise and reputation by tailoring the Company's solutions to the markets it serves. Each business unit has its own team of engineers and experienced sales people, including a network of agents. eaProSep Inc. (Montreal, Canada) Head Office ful ProSep proPureia rtoPure ME FroSepAp Europa & Middle East Asia Pacific America (Bergen. Norway) (Baleen) (Houston. USA) (Kuala Lumpur. Malaysia) Engineering Sales office Engineering Engineering Project Management Project management Project management Commissioning Manufacturing Manufacturing Product development Assembly Assembly (Fuca. Norway) Commissioning Commissioning 2.3 Business Environment and Strategy In 2009, the global upstream O&G market contracted significantly with the global financial crisis, recession and depressed energy demand. The International Energy Agency (lEA) estimated that upstream CAPEX spending in 2009 fell by approximately $90 billion, or by 22%' as many capital intensive projects were rendered uneconomical with the then prevailing price levels and recessionary environment. For 2010, the upstream oil and gas industry is back to growth after almost two years of decline. IHS, a leading source of industry information, forecasts an 8% growth in E&P investments at the world's leading publicly traded oil and gas producers' to $353 billion, while Barclays Capital forecasts the increase to be closer to 9% and reach $335 billion' by the end of this year. The lEA indicated in its monthly Oil Market Report (released mid-July 2010) that demand would reach an average of 86.5 million bpd this year, up from 84.93 million last year, although consumption in Europe still looks weak. Looking into 2011, the lEA predicts oil demand to grow exclusively on non-OECD demand, to 87.8 million bpd, with OECD demand continuing to decline (-0.5% or -0.2 mbpd)°. The organisation also forecasts an average price of $79.40 per barrel of oil in 2011. Increasing backlog The Company's backlog has been growing steadily since the second half of this year. Standing at $13 million at the end of the third quarter, the backlog is up 32% from $9.8 million at the end of the previous quarter. As discussed above, after falling significantly in 2009, oil and gas producers started increasing their CAPEX budgets in 2010. This has translated into increased opportunities in the industry and invitations to tender on larger projects. Since oil and gas producers contract EPCs for the design and construction of these new projects, there is a significant time delay between the initiation of the tender process and signature of supply 1Aliza Fan Dutt, senior equity analyst at !HS Herold quoted in a June 15, 2010 article "E&P Capital Moving from Offshore to Onshore US - Report", in Rigzone. IHS Herold 2010 Global Upstream Capital Spending Report 3 Barclays Capital Capital Original E&P Spending Survey midyear update, June 2010 IENs Oil Market Report published July13, 2010. www.omrpublic.iea.org 6 EFTA01158286 agreements. During the first half of the year, ProSep's bidding activity with EPCs reached record levels. This has resulted in increased backlog levels during the second half of the year. Revenues should start improving before the end of the year and continue through 2O11. Recent backlog trend $25 1 $20 $15 $10 $5 $0 6 „sa$ 44, ,C' ?..t• 4.14/" •ck vgb4- 6 IP O & a° 4e et- e Nt. (65 .<46 6 14 • )<S# ice 3 44- Stricter regulatory environment and new technologies The Deepwater Horizon accident that occurred on April 2O, 2O1O in the Gulf of Mexico led the USA Minerals Management Service (MMS) to institute a moratorium on deepwater drilling on the coast of the United States on May 27, 2O1O. The moratorium was lifted on October 12 with the provision that producers certify compliance with existing and new rules and requirements. It is still unclear how this accident and subsequent oil spill will affect the industry but it remains clear that the oil and gas industry will operate under tighter regulation and stronger oversights. With new discoveries moving offshore and in deeper, more challenging environments, it can be reasonably speculated that the increased attention on the offshore oil and gas industry should accelerate producers' willingness to invest in more efficient and sustainable technologies to mitigate the environmental impact of their activities. Because of its global operations and limited activity in the deepwaters of the Gulf of Mexico, ProSep has not been affected by the Deepwater Horizon accident. It is, however, too early to asses the future impact of this accident on the global offshore industry. ProSep remains cautiously optimistic about the industry's renewed growth and will continue to target areas of strong demand, such as South East Asia and Western Canada, and look at expanding its offering in new promising regions such as Latin America. It remains clear that, in order to meet projected demand growth' for fossil fuels, the industry will need to increase its investments to raise net capacity. The world's conventional proven reserves are depleting and new discoveries are mostly unconventional and offshore, and thus will require newer treatment technologies. As downhole improvements such as drilling, fracking and enhanced recovery have changed the profile of the industry, ProSep believes that innovative process solutions are needed to continue improving the economics of oil and gas production and face increased regulatory and environmental standards. swww.upstreamotine.com, October 35, 2010, "Some industry relef as Salazar lifts deep-water US Gulf drill ban 6www.upstreamonline.corn, May 31, 2010 a IEA sees 2010 boost in energy spend 7 EFTA01158287 ProSep's growth strategy To achieve its growth objective, ProSep will continue to focus on its core business. In 2009, the Company expanded its produced water treatment offering and invested in a larger state-of-the-art manufacturing facility. As a result, ProSep is able to package its various solutions for and bid on larger projects. This strategy started delivering results with recent produced water treatment sales, the supply of an important technology component for a high profile carbon capture project, and a $13 million CO2 gas treatment system. ProSep will also continue to expand its offering in new markets such as Western Canada and support its growing South East Asian business operations. By accelerating the validation cycle of promising technologies, ProSep plans to substantially differentiate its offering from the competition. By working to position the Company as a market leader in technology oriented process solutions, this key differentiation factor should lead to improved gross margins in a highly competitive environment. As the oil and gas equipment industry is entering a new economic cycle, ProSep must face and manage robust competition and increased pressure on gross margins. The challenge this year will be to position the Company on a solid profitability track to benefit from increasing market opportunities. To maximize resources, promote best practices in engineering and operations and improve its sales process and customer reach, ProSep has added two new members to its executive committee. Parag Jhonsa was promoted to coordinate and improve engineering and operations at all the Company's business units. His impeccable record at managing the Company's 55,000 square feet Houston fabrication facility will help other business units achieve the same level of operational excellence and seamless execution. The arrival of Douglas A. Campbell, a former sales and marketing executive at NATCO Group, will help expand ProSep's global reach and unlock significant value residing in some of the Company's proprietary step-change technologies. 3. PRODUCTS 3.1 Market Segments and Product Penetration ProSep's international team of engineers has developed extensive knowledge of process solutions for the upstream O&G treatment market. The Company's expertise lies in the development of technically advanced separation solutions to treat gas, oil and produced water for upstream production activities. Topside Oil and Gas Separation TOPSIDE WOND/ THIRDS,' ACA TO DOWNS-IMAM SEPAlialita OCX PROCESSING FIRSTSTAGG PEPARATION ) I ‘,vi rt DS SAJZ5 DISPOVIA. OP Irian-n0N WATCH 8 EFTA01158288 Whether recovered from onshore or offshore production facilities, the extracted hydrocarbon stream (oil, gas, water and solids) is brought to the surface (topside) to be processed and separated. Oil must be cleaned of salt and dissolved gas and other components; gas must be stabilized and cleaned of all liquids and unwanted components, such as hydrogen sulphide and carbon dioxide, before being commercialized. Produced water needs to be treated to remove all dissolved components, organic materials and solids before being disposed of or used for re-injection. 3.2 Product and Services Overview ProSep designs customer specific solutions by utilizing its wide range of equipment to separate. treat and polish well fluids and gas before they can be sent downstream for further refining, disposed of. or used for re- injection. The following is a diagram of the Company's core product offering/penetration: TYPICAL PROCESSING: SOLUTIONS: PROPRIETARY CONVENTIONAL OM ubr PruScae Svub:Jert QUA 2.3 phase FWKO.troators salkm; C3 mpuxom dehydrator: Solids ha WATER Dcsalnaton Sepaiatx, Tertiary Hydrocyclone5 Skim tanks. CPI Injection Clout separation CPI TORR and RPA Skim tanks cartridges Chlorine Gas floatation Solids handing Sorbfloc generationfeed Nutshell Deep bed filters Seawater treatment Co.owacnation ProStOrcoremasa oftwing 4 shown MM.. FWKO: Free Water Knockout CPI: Corrugated Plates Interceptor Process Design Experts: ProSep's process engineers have developed a wide range of complementary branded proprietary and conventional technologies. Offered as individual equipment or complete custom-designed packages, ProSep's technically advanced process solutions are used by O&G producers around the world to optimize separation and treatment of produced water, oil and gas. ProSep's solutions offer environmental and economic efficiencies, allowing oil and gas producers to meet industry and regulatory requirements while optimizing profitability. The Company believes that this is an important, unique value-added proposition as the industry faces increasing production challenges, such as diminishing production at older wells, difficult production environments, unconventional resources, and increasing use and co-production of water. 9 EFTA01158289 For a complete list and description of the Company's conventional and proprietary offering, refer to the most recent Annual Information Form, available at www.sedar.com and www.prosepinc.com. 4. RESULTS OF OPERATIONS 4.1 Contracts Sales originate from a number of contracts for the supply of conventional and proprietary gas, oil and water treatment systems to both large international oil and gas companies ("IOC") and national oil and gas companies ("NOC"). ProSep's systems have been delivered and installed on onshore and offshore oil and gas fields around the world. Table of Contracts Announced Since January 2009 Date Value Product Customer End User January 2009 US$3.7 M Fuel gas package •: Major EPC firm •: Asia Offshore IOC February 2009 US$1.2 M Separator Worley Parsons BP Exploration March 2009 US$2.0 M Fuel gas package Powertium/MMHE Petronas March 2009 US$2.1M Gas membrane units Whiting Petroleum Whiting Petroleum May 2009 $1.4 M ProDry "JIP" Total. Statoil. Con.Phil. • July 2009 $1M ProSalt ProDry BP. Con.Phil. Maersk BP. Con.Phil. Maersk October 2009 US$12.9 M Gas separation Ecopetrol Ecopetrol January 2010 $1M Water treatment (TORR) • •: Asia Offshore NOC January 2010 US$3.5 M Gas membrane • •: US Onshore producer January 2010 $3.6 M Water treatment (CTour) • •: Offshore super major March 2010 $0.4 M Proprietary mixer for CO2 Statoil. Norske Shell. Gassnova Statoil. Norske Shell. capture project Gassnova May2010 n/a Water treatment Dragados Dragados-Pemex May2010 US$2.2 M Water treatment • •: Asia Offshore July 2010 US$2.0 M Engineering and specialized • •: Super major producer in internals for crude separation Canadian Oil Sand market August2010 US$0.SM Chemical injection package • •: Asia Pacific August2010 US$41M Gas dehydration • •: Asia Pacific August2010 US$1.5 CO2 gas separation membrane • •: South America and hydrocarbon dew point packages August2010 US$0.5 Nitrogen generator package • •: South China Sea August 2010 US$0.4 Pitless air drilling de-duster skid • •: United States September 2010 US$2.0 After-market services and • •: Kuwait & United States spare parts October 2010 US$LS Additional equipment (including • •: South America spare gas membranes) •: Information could not be revealed for competitive reasons. 10 EFTA01158290 4.2 Revenues European & Consolidation & US Asia Pacific Consolidated Middle East Inter segment operations operations operations operations eliminations $'000 $'000 $'000 $'000 $'000 Three-month period ended September 30, 2010 Revenues 5,491 751 1,951 (53) 8,140 2009 Revenues 5,828 1,155 2,204 9.186 Nine-month period ended September 30, 2010 Revenues 16,516 4,979 4,810 (104) 26,201 2009 Revenues 21,058 3,815 7,231 (415) 31,689 Three-month period ended September 30 ProSep reported consolidated revenues of $8.1 million during the third quarter of 2010, a decrease of 11% from $9.2 million generated during the same quarter in 2009. Revenues for all three operations were affected by a weaker historical backlog, with the Europe and Middle East operations accounting for the largest share of revenue decline. Encouragingly, a significant increase in the total value of signed contracts, resulting in a 32% increase in the Company's backlog was noted in this quarter. This could lead to revenue growth in the upcoming quarters as these contracts are executed within a twelve-month period. Segment comments ProSep's LI5 operations generated 67% of the consolidated revenues, with sales of $5.5 million, down 6% from $5.8 million reported in 2009. The decrease in sales is mostly attributable to the unfavourable US currency exchange rate that negatively affected revenues by $0.3 million. During the third quarter of 2010, the average currency conversion rate for sales concluded at the US operations was 1.04 CAD/USD compared to 1.10 CAD/USD in 2009. Most quarterly revenues came from the advancement of the Ecopetrol and Whiting Petroleum gas skids contracts, as well as various orders for spare parts. The European and Middle East operations reported revenues of $O.8 million for the third quarter of 2010, representing a 35% decrease from $1.2 million reported for the corresponding period of 2009. Since most of this operation's offering is based on a relatively new suite of proprietary solutions, revenues are still volatile. As this offering gains technical validation and builds market recognition, quarterly revenue variations should be less significant. The Asia Pacific operations reported revenues of $2.0 million for the third quarter of 2010, down 12% from $2.2 million generated during the same period in 2009. Delays in the contractual completion of the glycol regeneration package, in part caused by change orders and requisitions, limited the operations' ability to recognize more revenues during the quarter. As of the date of this MD&A, the contract was delivered to the satisfaction of the customer. Nine-month period ended September 30 Year-to-date, ProSep reported consolidated revenues of $26.2 million, down 17% from $31.7 million in the first nine-months of 2009. Growth at the European and Middle Eastern operations was offset by decreased revenue at the Asia Pacific and US operations. Overall, lower order intake following residual weakness in upstream capital expenditure programs, increased competition, delays in contract completion at the Asian operations and unfavourable USD/CAD exchange rates explain most of the variance. 11 EFTA01158291  Segment comments ProSep's US operations reported year-to-date revenues of $16.5 million, 22% lower than the $21.1 million reported in 2009. Tighter market conditions resulting from the industry's downturn continued to affect ProSep's US operations and unfavourable exchange rates lowered revenues by approximately $1.8 million. The European andMiddle East operations reported revenues of $5 million, up 31% from $3.8 million reported for the first nine months of 2009. The sale of a large produced water treatment system during the first quarter, valued at $3.6 million for a super major operating in the North Sea, explains most of the revenue improvement year-to-date. The Asia Pacific operations recorded revenues of $4.8 million for the first three quarters of 2010, 33% lower than the $7.2 million reported for the same period in 2009. Changes in orders delayed the completion of an important contract for the supply of a glycol regeneration package, reducing the amount of revenues recognized during the first nine months of the year. This situation has been remedied and the system was recently delivered to the customers' satisfaction. Year-to-date, the value of the Malaysian Ringgit improved significantly against the US dollar. On average, the MYR/USD currency exchange was 3.03 compared to 3.60 during 2009. The value of certain contracts signed in USD was negatively affected by the appreciating value of the Ringgit, and impacted revenues by approximately $0.4 million in 2010. Management is currently developing a hedging strategy to protect revenues from such currency fluctuations. 4.3 Cost of Goods Sold and Gross Margin Three-month period ended September 30 US European & . Asia Pacific Consolidation & Consolidated Three-month period ended September 30 Middle East Inter segment Operations operations operations eliminations operations $.000 $'000 $'000 $'000 $'000 2010 Cost of goods sold 4,066 344 1,817 (53) 6,174 Gross margin 1,425 407 134 1,966 26% 54% 7% 24% 2009 Cost of goods sold 4.308 471 1.746 6.524 Gross margin 1,520 684 458 2,662 26% 59% 21% 29% The Company reported a consolidated gross margin of $2 million or 24% of revenues, down 5% from $2.7 million or 29% of revenues during the corresponding quarter of 2009. During the quarter, gross margins were in line with recent historical performance except at the Asia Pacific Operations. Rapid growth experienced by this operation led to difficulties in executing certain contracts. ProSep has taken the necessary steps to ensure that this business unit has access to additional resources, allowing it to reach the same level of seamless execution and cost controls that the other more established operations have achieved. Segment comments ProSep's US Operations reported a gross margin of $1.4 million or 26% of revenues, in-line with $1.5 million or 26% during the third quarter of 2009. Strict controls over engineering, procurement and operations at the Company's largest fabrication facility have been successful at maintaining sustainable gross margin levels in a highly competitive market. The European and Middle East operations reported a gross margin of $0.4 million or 54% of revenues, slightly lower on a percentage basis that the $0.7 million or 59% of revenues that occurred in the same quarter of 2009. This business unit almost exclusively designs, engineers and fabricates proprietary solutions that command higher gross margins. Depending on the type of contract and contract mix during the period, margins can vary but not significantly. 12 EFTA01158292 The Asia Pacific operations reported a gross margin of $0.1million or 7% of revenues during the third quarter of 2010, compared to $0.5 million or 21% for the corresponding period of 2009. Excluding extra costs related to challenges at the Company's newest operations and currency fluctuations, the third quarter normalized margin would have been in the 20% range, in line with historical performance. Nine-month period ended September 30 US European & Asia Pacific Consolidation & Consolidated Nine-month period ended September 30 Middle East Inter segment Operations operations operations eliminations operations $.000 $4000 $4000 $'000 $'000 2010 Cost of goods sold 12,536 2,210 4,444 (104) 19,085 Gross margin 3,980 2,769 366 7,115 24% 56% 8% 27% 2009 Cost of goods sold 15.093 1,845 5.571 (415) 22.094 Gross margin 5.965 1.970 1.660 9.596 28% 52% 23% 30% Year-to-date, the USand European andMiddle East Operations were the largest contributors to consolidated gro